accounting essay

Calculation Of Payback Npv And Irr Accounting Essay

Published: 23, March 2015

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The consequences of the proposals are tracked for five years. This research has encountered benefits that nominated proposal contributes to the organisation by calculating NPV, Payback and IRR. These are the method which determines how much profit does the proposal contribute to the organisation, which would help the board of AP PCL to decide, which proposal is financially productive.

Productivity of any proposal can be calculated by four traditional methods.

Payback (PP)

Net Present Value (NPV)

Interest Rate of Return (IRR)

Profitability Index (PI)

Calculation of Payback , NPV and IRR for each proposal

Proposal first

Yr.

Annual CF

Cumulative CF

Discount at 10%

PV

Discount at 20%

PV

Discount at 25%

PV

0

(100000)

-

1

-

1

-

1

-

1

0

0

0.9090

0

0.8330

0.8000

2

0

0

0.8260

0

0.6940

0.6400

3

&pound; 73000

&pound; 73000

0.7510

54823

0.5790

&pound; 42267

0.5120

37376

4

&pound; 73000

&pound; 146000

0.6830

49859

0.4820

&pound; 35186

0.4096

29900.8

5

&pound; 73000

&pound; 219000

0.6210

45333

0.4020

&pound; 29346

0.3276

23914.8

NPV @ 10%

=50015

NPV @ 20%

= 6799

NPV @ 25%

(8808.4)

Payback period = 3 + [(100000-73000)/73000]

= 3 + (27000/73000)

= 3 + 0.4 years

= 3 + (0.4 - 12) years

= 3 years and 5 months

Calculation for IRR

NPV @10% is 50015

NPV @20% is 6799

NPV @25% is (8808.4)

= 20% + {6799/(6799-8808} * (25% - 20%)

= 20 % + (6799/15607) * 5%

= 20% + 0.4 - 5%

= 20% +2%

= 22%

Proposal second

Yrs.

Annual CF

Cumulative Cash Flow

Annuity at 10%

Present Value

Annuity at 20%

Present Value

Annuity at 30%

Present Value

0

(180000)

-

1

-

1

-

1

-

1

&pound; 66000

&pound; 66000

0.909

&pound; 59994

0.833

&pound; 54978

0.769

&pound; 50754

2

&pound; 66000

&pound; 132000

1.736

&pound; 114576

1.528

&pound; 100848

1.360

&pound; 89760

3

&pound; 66000

&pound; 198000

2.487

&pound; 164142

2.106

&pound; 138996

1.815

&pound; 119790

4

&pound; 66000

&pound; 264000

3.170

&pound; 209220

2.589

&pound; 170874

2.165

&pound; 142890

5

&pound; 66000

&pound; 330000

3.791

&pound; 250206

2.991

&pound; 197406

2.434

&pound; 160644

NPV @ 10%

= 70206

NPV @ 20%

=17406

NPV@ 30%

=(19356)

Payback period = 2 + [(180000-1320000)/66000]

= 2 + (48000/66000)

= 2 + 0.73 years

= 2 + (0.73 - 12) years

= 2 years 9 months

Calculation for IRR NPV @10% is 70206

NPV @20%is 17406

NPV@30% is (19356)

= 20% + {17406/ (17406+19356) * (30%-20%)}

= 20% + (17406/36762) * 10%

= 20% + 0.5 - 10%

= 20% + 5 %

= 25 %

Proposal third

Yr.

Annual CF

Cumulative Cash Flow

Discount at 10%

PV

Discount at 20%

PV

Discount at 30%

PV

0

(200000)

-

1

-

1

-

1

-

1

&pound; 145000

&pound; 145000

0.909

&pound; 131805

0.833

&pound; 120785

0.769

&pound; 111505

2

&pound; 145000

&pound; 290000

0.826

&pound; 119770

0.694

&pound; 100630

0.591

&pound; 85695

3

0

0

0.751

0

0.579

0

0.455

0

4

0

0

0.683

0

0.482

0

0.350

0

5

0

0

0.621

0

0.402

0

0.269

0

NPV @ 10%

&pound; 51575

NPV @ 20%

&pound; 21415

NPV@ 30%

(2800)

Payback period = 1 + [(200000-145000)/145000]

= 1 +(55000/145000)

= 1 + 0.4 years

= 1 + (0.4 - 12) years

= 1 years 5 months

Internal Rate of Return NPV @10% is 51575

NPV @20% is 21415

NPV @30% is (2800)

= 20% + {21415/ (21415+2800)* (30% -20%)}

= 20% + (21415/24215) * (30% - 20%)

=

= 20% +8.4

= 28.4%

Proposal fourth

Yrs.

Annual CF

Cumulative Cash Flow

Annuity at 10%

PV

Annuity at 20%

PV

Annuity at 30%

PV

0

(40000)

-

1

-

1

-

1

-

1

&pound; 16000

&pound; 16000

0.909

&pound; 14544

0.833

&pound; 13328

0.769

12304

2

&pound; 16000

&pound; 32000

1.736

&pound; 27776

1.528

&pound; 24448

1.360

21760

3

&pound; 16000

&pound; 48000

2.487

&pound; 39792

2.106

&pound; 33696

1.815

29040

4

&pound; 16000

&pound; 64000

3.170

&pound; 50720

2.589

&pound; 41424

2.165

34640

5

&pound; 16000

&pound; 80000

3.791

&pound; 60656

2.991

&pound; 47856

2.434

38944

NPV @ 10%

= 20656

NPV @ 20%

= 7856

NPV@ 30%

= (1056)

Payback period = 2 + [(40000 - 48000)/16000]

= 2 + (8000/16000)

= 2 + 0.5 years

= 2 + (0.5 - 12) years

= 2 years and 6 months

Internal Rate of Return NPV @10% is 20656

NPV @20% is 7856

NPV@30% is (1056)

= 20% + [7856/ (7856+1056) * (30%-20%)

= 20% + (7856/8912)* (30%-20%)

= 20% + 0.9 - 10%

= 20% + 9

= 29%

Proposal fifth

Yr.

Annual CF

Cumulative CF

Annuity at 10%

PV

Annuity at 95%

PV

Annuity at 97%

PV

0

(70000)

-

1

-

1

-

1

1

&pound; 70000

&pound; 70000

0.909

&pound; 63630

0.5120

35840

0.5076

35532

2

&pound; 70000

&pound; 140000

1.736

&pound; 121520

0.7740

54180

0.7652

53564

3

&pound; 70000

&pound; 210000

2.487

&pound; 174090

0.9088

63616

0.8954

62678

4

&pound; 70000

&pound; 280000

3.170

&pound; 221900

0.9779

68453

0.9622

67354

5

&pound; 70000

&pound; 350000

3.791

&pound; 265370

1.0134

70938

0.9959

69713

NPV @ 10%

195300

NPV@ 95%

938

NPV @ 97%

(287)

Payback period = 1 + [(70000 - 70000)/70000

= 1 + 0 year

= 1 year

Internal Rate of Return NPV @10% is 195300

NPV @95% is 938

NPV@97% is (287)

= 95% + [938/ (938+287) * (97% - 95%)

= 95% + (938/1225) * 2%

=

= 95% + 1.54%

= 96.54%

ASSESSMENTS OF THE PROPOSAL

Assessments of nominated proposals can be achieved by calculating the Profitability Index Profitability index is used usually when the organisation is lacking with capital investment. This is an essential tool used to rank the qualifying proposals according to expected profit generated.

Profitability Index: - Profitability is also known as (PIF) that stands for Profit Investment ratio P.I. is the ratio of NPV to payoff of the proposal. This computing is used in a great degree for the calculation of proposal providing profit. Projects with high index produces more profit.

Profitability Index = NPV / Initial Investment

For proposal 1 = = 0.50

For proposal 2 = = 0.39

For proposal 3 = = 0.25

For proposal 4 = = o.51

For proposal 5 = = 2.79

As per above calculation, proposal fifth is acceptable.

Profitability has a simple concept that the ranking is dependent on profitability index If the Index is lesser than 1 than proposal should be rejected if it is more than one than It should be accepted. If in case there are more than one proposal qualifying these criteria ranking is done in descending order the highest index first then the second to it and so on. But here only one proposal is qualifying so board has only one option that is proposal 5

ELEMENTS FOR FINAL CONCLUSION

A proposal is effected with the modification in environment such as Inflation and Taxation. While choosing a proposal boards should conceive these significant factors.

Inflation: - Inflation is one of the major cause which can affect the profit of business . In other words Inflation means the value of cash flow now will not be same after one year it will rise to some extent. For instance if price has risen by 5% in a year then we will spent &pound; 1.5 in a duration of one year to purchase the same product or service of &pound; 1 today. There are two methods by which inflation is allowed in capital investment they are indexing and adjusting the rate of return.

Indexing;- In Indexing the cash flow is indexed by a pre-assumed amount.

Adjusting; - The value of money is calculated in account with an annuity or discount factor.

Taxation:- Taxation is based on annual gain by the organisation .to calculate the annual taxation financial gain is set for depreciation .Tax concessions are not made in account at the time of accounting profit ,examples for capital margin are tax allowance .

SUPERIORITY OF NPV OVER POPULARITY OF IRR

By doing different computation, how investment is done in management is called capital investment appraisal. Exactly what amount of money has to be invested in an organisation is easily known by doing various calculative methods. Capital investment appraisals can be examined by using two main methods , that is discounted cash flow and traditional method and these methods are further subdivided in five methods that can be used in capital investment appraisals .they are pay back , discounted PAYBACK,ARR, NPV AND IRR., and here we are about to discuss mainly the NPV and IRR.NPV is net present value means it's the timing value of capital. NPV is highly recommended method for CI appraisal because it shows the exact timing of cash flow benefit in project and the payback /actual return of investment .Accountant can very easily decide to invest in the project by calculating NPV, as if NPV is acceptable then only project .even if with NPV negative sometimes projects are accepted or run only when they show there their interest in employers security whereas IRR is the second method which is also based on discounting IRR evaluates that at what rate of interest is required or needed to get the exact investment back. This method is much similar to NPV as in NPV we calculate that the project is acceptable or by estimating the timing of rate of return of initial investment and the only difference between NPV and IRR is that IRR can easily estimate the approximate rate of return in order to get the cost of initial input, Whereas IRR is supposed to be much more used among organisational business. On the other hand NPV is superior in terms that it estimates whether the investment is beneficial for the organisation or not as if NPV is acceptable than projects should be carried on and we can invest. Even if the NPV is not acceptable or negative there is a chance of investment with no profit no loss

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